Directors – don’t let a failing business drag you under

Persistence is an admirable quality but unfortunately it can sometimes work against directors who take personal risks when trying to save a failing business.

Sometimes the heart can rule the head.

Directors often have an emotional attachment to a firm they have set up themselves and feel a tremendous loyalty to their staff. This can blind them to the fact that their business has no chance of avoiding insolvency.

Or it could just be down to money. For example, they may be trying to avoid having to pay back company loans which they have personally guaranteed.

The trouble is that if they soldier on too long trying to rescue a lost cause, they could be accused of wrongful trading and face financial ruin as they become liable for the debts of their business – even if it is a limited liability company.

As soon as a company becomes insolvent, directors have a legal duty to protect the interests of creditors. When formal insolvency procedures get underway, the behaviour of directors over the previous few years could come under investigation.

They could become liable for wrongful trading if it’s found that they continued entering into contracts or accepting credit after they knew or should have known there was no reasonable chance avoiding insolvent liquidation.

The court could then order them to use their personal assets to help settle the company’s debts.

Directors of insolvent companies are also obliged to treat all creditors equally, so they must not give preferential treatment to friends or a company that is threatening to sue them.

Many directors find it difficult to recognise or accept the point at which they become insolvent, so they should seek professional help as soon as problems start to emerge.

People who run their business as a partnership could be even more at risk because they
could be personally liable for debts if their firm becomes insolvent. It can mean they not only lose the business they have spent years building up, they may also lose their personal savings and even their homes in some cases.

The answer could be to consider restructuring the business as a Limited Liability Partnership (LLP). There are several advantages to becoming an LLP – including possible tax benefits – but the main one in the current economic climate is that it helps to ensure that liability lies with the business itself rather than with the individual partners.

The personal assets of each partner should be protected in most circumstances if the business fails, although they would still have to meet their other legal responsibilities as we have seen, or they might still be liable.

Directors also have a legal responsibility to take action if they discover that other directors are acting fraudulently or dealing inappropriately with company funds – an issue that could easily emerge as a business starts to fail. Failure to do so could render them liable for subsequent losses.

Please contact Sarah Liddiard if you would like more information about the issues raised in this article or any aspect of company law and directors’ duties.